In actual fact, the key question here, is: ‘what’s the difference between discounting and factoring?’

Both ‘bill discounting’ and ‘invoice factoring’ are types of financial instruments that are used to provide working capital to businesses from accounts receivables (i.e., unpaid invoices).

Providing working capital for unpaid invoices is a lifeline for both small and large businesses, but it’s important to understand the difference between ‘factoring’ and ‘discounting’. The terms are often used interchangeably, but technically you would be wrong to do so. In this article, we outline the key differences between the commonly used terms ‘bill discounting’ and ‘invoice factoring’.

Bill Discounting

Bill discounting, or invoice discounting is the act of sourcing working capital from future payables. Furthermore, the seller recovers a number of sales from the financial intermediaries before the due date.

Bill discounting can be defined as the advance selling of a bill to an intermediary (an invoice discounting business) before it is due to be paid. This results in less administrative charges, fees, and interest. The interest and fee are calculated based on the risk of non-payment from the buyer, and so a funder will look at the creditworthiness and trading history of the customer rather than the business it is funding for payment.

In this arrangement, the initial owner of the invoices that are sold on is still in control of its own sales ledger and will chase payment in the usual way.

Receivables Discounting Diagram
NOTE: we use the term ‘receivables’ in lieu of ‘bills’, but the concept is still the same – bills, or invoices, are discounted through a finance provider.

Invoice Factoring

Invoice factoring involves a third party which is placed between the buyer and the supplier. The third party – who is the factor in this scenario – purchases a company’s accounts receivables (unpaid invoices) at a discounted rate. This gives the company in question access to a pool of funds that were tied up in the future. It also gives the third party higher value debt which will eventually pay.

There is, of course, Reverse Invoice Factoring, in which the third party commits to paying the company’s invoices at an earlier date in exchange for a discount. They then take their fees out and pass it onto the company involved.

Want to read more? We interviewed two industry experts Anthony Brown and Antonio Salgueiro on how factoring can help businesses

The Difference

It all boils down to who takes the liability of the sales ledger, and who claims the responsibility of collecting payment. Correspondingly, there lies an essential variation in the confidentiality surrounding the instrument:

Invoice Factoring in 30 seconds:

  • The third party takes responsibility for the sales ledger, and will also carry out the chase of payments and credit control surrounding the transaction.
  • The customer will settle their invoice with the third party factor. Consequently, customers are more likely to be aware of the factor arrangement in place, which may cause issues as the company is technically accepting a lower price.

Invoice Discounting in 30 seconds:

  • The original company that owns the accounts receivables will continue its obligations to chase payment and fulfil the upkeep of the sales ledger.
  • The customer will still pay the company directly, and not the third party. Therefore, the customer has no way or right to know about any discounting arrangement applied to the transaction.
Sometimes we insert pictures of cats in our articles. It keeps the conversation light and easy to read. We’re only partially joking. But while you’re here, we thought we’d link you through to an interesting article on the future of factoring, and it’s role in a post COVID-19 world. Read the expert interview with Peter Mulroy, Secretary General, FCI here.

What are the advantages of bill discounting?

Invoice financing has many pros for small and medium-sized businesses, the main being a material improvement in the businesses access to liquid cash.

  • Improved cash flow and working capital
  • Can be good for start up businesses, or those without a credit rating as they’ve just set up
  • The borrower only pays on the amount of money used, unlike a business loan
  • Risk of bad debt or non-payment can be passed on to the financier
  • Quick to access – funds can be released within 24 hour

The devil is in the detail

As with all invoice financing products, it’s important to understand where the liability and risks lie in the transaction. As a business, it’s important to understand your obligations of such transaction. We’ve put some tips and tricks together in our SME Finance guide, which can be found here.

At Trade Finance Global, our global team of receivables and invoice finance experts are here to help your business. Visit our receivables finance hub here, to see how you can access discounting or factoring services.